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Commentary: Wall Street's 200 Year Old Rip Off

March 30, 1997

Finance: COMMENTARY

COMMENTARY: WALL STREET'S 200-YEAR-OLD RIP-OFF

Would you buy a car from a dealer who set his prices in $500 increments--knowing how much harder that would make it to haggle him down? Or would you shop at a grocer who rounds his prices up to the next quarter?

Ridiculous? Yes, but investors are subjected to just such practices every time they buy or sell stocks. That's because market makers are prohibited from trading stocks in less than one-eighth intervals: If a stock trades at 10, traders are guaranteed at least a 1/8 point (or 12.5 cents) profit when they sell to new investors--even if true demand would justify a smaller spread. While technology has changed the financial system in many ways, the custom of trading stocks in one-eighth increments is a not-so-quaint remnant of the 1700s, when the Spanish peseta--or "piece of eight"--was the accepted international currency. The current system is "a relic of the days of knee britches and powdered wigs...that prevents market forces from working," gripes Representative Edward J. Markey (D-Mass.). That's why Markey and fellow House member Michael G. Oxley (R-Ohio) have introduced a bill requiring decimal pricing.

SPREAD PINCH. It's high time for Congress to act on Markey and Oxley's bill and force the nation's exchanges to price stocks like all other goods and services--in dollars and cents. The payoff would be enormous: Securities & Exchange Commission member Steven M.H. Wallman estimates the shift would result in $5 billion or more in savings for investors at the expense of market makers.

U.S. investors need only look northward to see the benefits of decimal pricing. In the 11 months since the Toronto Stock Exchange made the switch, spreads have been cut by 21%, to an average of 20.5 cents, for most stocks trading above $5, according to a study by Jeffrey M. Bacidore, a visiting lecturer at Indiana University. Many trading experts believe widely held NASDAQ stocks such as Microsoft Corp. and Intel Corp. would suddenly trade at spreads of about a nickel--a savings of $7.50 for every 100 shares bought or sold.

Predictably, market makers argue that a seismic shift would eat into profits, rendering them unable to fill larger orders and leaving markets less liquid and more volatile. "I have great concern about stocks trading at 17 to 17-and-a-penny," says E.E. "Buzzy" Geduld, president of Herzog, Heine & Geduld Inc. "This could cause the marketplace to dry up."

Geduld's warnings aside, the rampant Wall Street practice of "payment for order flow"--in which dealers pay stockbrokers a kickback of a few pennies for every share routed their way--is a tacit admission that the current spreads are plenty wide.

Shifting to dollars-and-cents pricing could lead to a dealer shakeout. But that's a small price to pay for lower investor costs. And it might force the survivors to shift toward automated execution systems. Whatever the case, it's time for the stock market, the bastion of capitalism, to be governed by market forces.By Dean Foust